Tax Traps: Don't Get Stung by Estate Taxes

Many farmers breathed a sigh of relief when Congress a couple years ago enacted a $5 million lifetime federal exemption for estate tax, indexed to inflation. This year, the exemption is $5.34 million.

"So, if you are married, a farm couple can actually give away almost $11 million either during their lifetime or at their death, completely tax free," says Paul Neiffer, The Farm CPA.

The problem is that, given the rapid rate of farm appreciation in recent years, $10.68 million might not go very far.

"That may sound like a lot of money, and several years ago for our farm economy, it was. But now we’ve seen farmers in Iowa or Illinois get $15,000 an acre for their farm." If the farm is 1,000 acres, Neiffer says, "they are looking at owing taxes. We have lots of farmers out there with multiple thousands of acres."

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Farmers in their 40s or 50s could wind up with a big estate tax burden by the time they reach their 80s or 90s, unless they do estate tax planning now. "If farmland values continue to grow at the rate they are growing, they could very easily face owing Uncle Sam, and their state, $5 million, $10 million, $15 million in taxes," Neiffer explains.

The federal estate-tax exemption may be $5.34 million, but 15 states still levy an estate tax, though some grant farmland exemptions. "I live in Washington State," Neiffer says. "Our estate tax kicks in at $2 million. The state just south of us, Oregon, it kicks in at $1 million."

One way to reduce state estate tax liability is to move to another state such as Arizona, Texas or Florida, which don’t levy state estate taxes. The key is to eventually live their more than six months out of the year.

"A lot of our farmers, when they get a little older, become snowbirds. They’ll live in Texas in the wintertime and Minnesota in the summertime," says Neiffer, adding that even if Florida becomes your primary residence, you may still owe a state such as Oregon some estate tax, just because that’s where the farmland is located.

The other weapon farmers have at their disposal is gifting. The annual tax-free exclusion in 2014 is $14,000 per person that can be given to each child or grandchild. The money will compound if put away in the right investment vehicle. And it will lower how much of an estate is subject to estate taxes.

Consider a farm couple with three children who each have four children. A husband and wife who jointly own the farm could each give each child and grandchild $14,000, or about $420,000, says Neiffer.

"And if we’re dealing with farmland that’s been placed in an LLC," says Neiffer, "we can take ‘appropriate marketability’ and ‘minority interest’ discounts on that, and we can drop that value of the farmland—let’s say it’s $750,000—we could drop it down to close to $500,000 or even less.

"In that case, we might still file a gift tax return. But we don’t owe any gift tax. We don’t eat into our lifetime estate tax exclusion of $5.34 million. It’s just a way of making sure, especially if you have a farm couple with a farm worth between $10 million to $15 million, of getting the value below that $10.68 million threshold and keeping it below."